As the short-term risk-reward appears less attractive, we have tactically reduced our equity exposure

Executive summary

Also, from a regional point of view, we have made some changes, becoming temporarily more cautious on EMU, while maintaining Japan and Emerging Markets as our biggest convictions.

Bonds: emerging debt remains the main attractive asset class.

Main convictions

Visibility

Visibility on growth beyond the second half of 2018 is becoming somewhat blurred outside the US.

We recognize the rise in inflation uncertainty in the US, despite the fact that inflation remains contained.

Overall, the Goldilocks scenario is being challenged.

Short term, we see a less favourable risk-reward.

Valuations

Valuations have become less stretched after the recent correction.

Credit, although still reflecting sound fundamentals, is expensive.

Volatility

The volatility spike across most asset classes, particularly on equities, is a new factor of uncertainty.

Momentum in bond yields and the price of oil are under increased watch.

To move towards a durably higher volatility regime would require a shock on growth and the fear of recession in just one key region or an unexpected acceleration in inflation.

Cross-Asset strategy: regional portfolio positioning

General overview: Equities vs. Bonds

Although the economic context has been robust since the beginning of the year, momentum, as measured by the economic surprises, has slowed somewhat outside the US, as the expansion becomes more mature. Fundamentals remain, nevertheless, solid.

Inflation pressures seem overestimated by the market. Although it is true that inflation is gradually coming back in the US, it remains tame on a global scale, while real yields remain remarkably low. Meanwhile, markets are converging towards the US central bank’s progressive monetary tightening.

Geopolitics have, nevertheless, captured investors’ attention. In the US, Gary Cohn resigned, while Donald Trump is creating trade war fears. In Europe, Italian elections confirmed the rise of populism. Investors are thus showing signs of anxiety, considering inflation and a possible bond market crash as the main concerns, according to the BofA-ML Fund Managers’ Survey. In this context, we have adopted a more cautious short-term view on equities.

For fixed income, expected returns remain slightly negative, except for the emerging-debt and high-yield asset classes, where sovereign rate forecasts are not too far from current levels and spreads have already reached our target.

In this context, our fundamental, technical and quantitative analyses lead us to favour Equities over Bonds.

Regional equity strategy

Tactically more cautious on EMU equities

Economic indicators, as well as technical and quantitative analyses, seem to be converging to make EMU equities less attractive than the US and the emerging markets. The Euro appreciation had an impact on European corporate profits, leading to lower expected returns for this region. In the same way, Japanese equities have been subject to yen appreciation. In the US, expected returns have increased, thanks to strong earnings from the growth that comes with Trump’s tax reform. However, this had already been largely priced in by equity markets

Neutral in US equities: Trump’s fiscal easing has now been integrated into earnings growth expectations.

We have trimmed EMU equities to neutral: despite solid fundamentals,the market needs new catalysts to accelerate the momentum. As Euro appreciation is impacting European corporate profits, we have lowered our expectations to +8%.

Japanese equities: the visibility on an accommodative policy mix and an above-potential expansion is good news, but the market has suffered from yen appreciation.

We have maintained a negative view on Europe ex-EMU equities. Earnings growth will no longer benefit from GBP depreciation as the year-on-year effect fades. Domestic fundamentals are weakening and downside risks remain.

Fixed income strategy

Negative on government bonds but positive on high-yield and emerging debt

With a tightening Fed and expected upcoming inflation pressures, we assume rates and bond yields will continue their uptrend. We thus continue to diversify out of low-yielding government bonds. Our strongest conviction is emerging debt, as the ongoing monetary easing is highly supportive of this asset class. Also, emerging debt is benefiting from strong global economic growth and the increase in commodity prices. Meanwhile, fundamentals remain solid, with low public debt, an improving current account and a still-attractive carry.